Turkish bank bonds have become a lightning rod for investors' negative sentiment, but solving the country’s crisis of confidence as to its wobbly macro situation is key to a sustained recovery, as the fundamentals remain solid, Nicholas Smallwood of ING Bank said on July 6 in a research note.

The problems with Turkish banks have been highlighted by the Iran sanctions-busting case involving Halkbank. ING Bank believes that a painful but ultimately manageable fine for Turkey’s state-owned Halkbank (maybe around $1bn-$2bn) remains the most likely outcome.

US prosecutors said on June 26 they plan to appeal against the length of prison term given to Mehmet Hakan Atilla, the international banking head of Turkey’s state-owned Turkiye Halk Bankasi (Halkbank) convicted of aiding an Iranian plot to evade sanctions and launder $1bn in oil revenue through the US financial system.

The case has undermined confidence in the whole sector. On 8 June, Moody’s downgraded all Turkish banks but QNB Finansbank to Ba3 and left them on review for further downgrade to reflect the status of the sovereign (Ba2/review for downgrade).

ING Bank sees Moody’s action as harsh.

“Turkish banks’ liquidity position is such that they can withstand a prolonged market shut-out. In aggregate, they have $90bn of liquid assets covering $55-60bn of maturities in the next year,” Smallwood also said.

The Turkish banking sector’s overall loan volume rose by 24% y/y to TRY2.34bn in January-May while the lenders’ combined profit rose by 13% y/y to TRY23.8bn.

The key driver of profit growth was an increase in revenues, driven by loan growth, offset by falling net interest margin as funding costs rose. ING Bank expects slowing activity and tight monetary policy to reduce bank profitability in the second half of 2018 from the very high levels of the past year.

A key feature of the first quarter of 2018 was the weakening of asset quality, said Smallwood.

While headline NPL ratios remained steady, credit costs and Group II loans surged following the introduction of IFRS 9 and restructuring requests from a few large corporates. ING Bank remains fairly confident that widespread corporate restructuring are not imminent; in fact, it had no further news on this front in the second quarter.

However, ING Bank questions how long SMEs can bear up in this difficult environment. It expects gradual weakening in the credit metrics of this sector, though the Credit Guarantee Fund (CGF), strong provisioning and good collateralisation of non-CGF loans make ING Bank think that banks are well placed to weather any developing squalls.

A trio of top Turkish banks saw their borrowing costs hit record highs on June 15 as mounting pressure on the Turkish lira (TRY) ahead of the June 24 elections sparked more selling on Turkey’s bond markets, Reuters reported.